Market 'overreacting' to Ardent Leisure's Texas exposure

By James Lennon

Ardent Leisure's share price has experienced some headwinds recently due to market-wide falls. In addition, as the group's US-based Main Event Entertainment division has a large exposure to Texas, investors have also fretted that weakness in oil prices will be having a negative impact.

In our view, the market is excessively discounting the impact on a number of levels and the reality is that the Main Event bowling entertainment centres in the US have proven to be resilient during previous downturns. In addition, the company is diluting its exposure to Texas by successfully expanding its footprint in other states. This will allow the business to benefit from a robust recovery of the overall US economy and drive future group revenue growth.

Ardent Leisure chief executive Deborah Thomas has the performance of the health clubs business high on her list of priorities.Credit:Jessica Hromas

Disclosure: Ardent Leisure is held in the Fat Prophets Income Model Portfolio.

This was evident in Ardent Leisure's financial results for the first quarter of the 2016 financial year, with the company having recorded strong revenue growth of 19.3 per cent, reaching $165.96 million, underpinned by an accelerated expansion of its Main Event division that is predominantly based in Texas. Main Event operations recorded revenue of $US37.42 million, up 30.8 per cent from the corresponding period last year, while EBITDA (earnings before interest tax depreciation and amortisation) rose by 28.2 per cent to $US8.33 million.

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We believe the strong performance in the main event will continue and remains as the key growth driver for the group as management aims to accelerate this national rollout with seven new centres scheduled to open in the second half of the 2016 financial year and eight centres in the 2017 financial year. This expansion plan will bring the total number to 35 in late financial year 2017, representing a 75 per cent increase in the current portfolio size of 20 centres. Importantly, six of Ardent Leisure's 20 centres are operating successfully in the states beyond Texas.

As Main Event is recognised as the fastest-growing bowling entertainment offering in the US, we expect the expansion plan will allow the business to benefit from a robust recovery of the overall US economy and drive the group's future revenue growth. A lower Australian dollar will also deliver gains to the bottom line as US earnings are translated back.

Looking at Ardent Leisure's financial performance more broadly, we note that the company's Theme Park operations also contributed strongly to Ardent Leisure's earnings with EBITDA of $10.08 million, up 4.8 per cent from the previous corresponding period. The positive trends were attributable to a successful marketing campaign and solid customer growth from the Chinese and New Zealand markets on the back of a weaker Australian dollar.

In contrast, Ardent Leisure's Health Clubs division continues to face profit pressures with EBITDA dropping 26.8 per cent compared to the first quarter in FY15. More encouragingly, the Goodlife Health Clubs has seen significant membership growth. Membership sales across 25 converted (to a 24/7 format) clubs were up 32.8 per cent while the churn rate is down 19.3 per cent from the previous corresponding period. We believe the health clubs business will continue to turnaround with chief executive Deborah Thomas having it high on her focus list.

Price

From a fundamental standpoint, Ardent Leisure is trading on a forward earnings multiple of 13.7 times (based on the 2016 financial year) and offering a yield of 7.1 per cent. These attractive price metrics appear to be supported by a favourable technical set-up, with a bullish divergence potentially in the making (this is when a new low is formed in price, however the same is not reflected on the RSI).

Worth buying?

In our view, the market has placed undue emphasis on the prospect of weakness at Ardent Leisure's Texan operations in the wake of further declines in the oil price.

The reality is that the company's bowling entertainment centres in the US have proven to be resilient during previous downturns. Furthermore, to diversify the risk, the company is diluting its exposure to Texas by successfully expanding its footprint in other states. This will allow the business to benefit from a robust recovery of the overall US economy and drive future group revenue growth.

Greg Smith is Head of Research at investment research and funds management house Fat Prophets. To receive a recent Fat Prophets Report, CLICK HERE.